the major consequences of bank
failures on financial stability, and out of the realization that a banking
crisis is inevitably repetitive, governments decided to take precautionary
measures in order to avoid the occurrence of bank runs. These measures
considered the studies that explored the different reasons behind the bank runs.
This paper will inspect policies tackling banking crises which act as
safeguards to the banking system and the economy as a whole.
In response to the Bank turmoil of
the 1930s, government officials and monetary policymakers implemented certain
policies in order to avoid bank runs and consequently lessen the risks accompanying
them. Applying counter policies to escape the negative repercussions of bank
runs is at the root of capital sufficiency requirements and deposit insurance.
Federal deposit insurance was created
to avoid bank runs, and subsequently a large number of banks during the Great Depression
in United States urged the federal government to implement this, believing that
depositors under insurance would react less to mass runs than those without. However,
the insurance is only partially effective. According to Jacklin (1987), banks
should offer insurance in order to compete in financial markets; this piece of literature,
and these types of policies, gave the depositors a way to protect their
deposits and investments.
Understanding the origins of bank
failures and the sudden deposit withdrawal is considered the first and most
crucial phase when applying the policy which counters bank failures. For
example, if bank failures are caused by fundamental factors, then the policymakers
should work on supporting the financial regulation and supervision of a banking
system acting as a monitoring system for bank failures. Meanwhile, the Madiès
(2006) model emphasizes the efficiency of applying an equivalent preventive
method to avoid bank runs, which is relevant to bank failures that results from
depositor’s confusion in the face of asset value shocks. This model was the
first to offer an experimental study of mis-coordination based bank runs within
Diamond and Dybvig’s model.